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Diversification is always a crucial consideration for investors. But it appears particularly pressing at present. As the global economy strengthens, inflation, interest rates and bond yields are creeping up. And after a decade-long bull run, the equity market is looking fragile, with stock-market volatility at its highest level since 2011.
Meanwhile, the geopolitical situation remains as unpredictable as ever. Heightened tensions between Russia and the West, instability in the Middle East, and the growing threat of a trade war between the US and China: these uncertainties provide considerable scope for market reversals.
All of this means that investors should take diversification very seriously. The evidence suggests they are doing just that. Some ‘alternative’ assets have become almost mainstream in recent years, with property and private equity, for example, becoming increasingly common components of portfolios.
…we think that investors should pay greater attention to more esoteric asset classes…
As multi-asset investors, we are always trying to diversify our clients’ portfolios beyond the mainstream. So, as the mainstream broadens, we think that investors should pay greater attention to more esoteric asset classes that offer different returns streams to both traditional asset classes and the better-known ‘alternatives’. These ‘alternative alternatives’ are areas in which we have been investing for some time.
With stable cash returns increasingly hard to find in traditional ‘fixed-income’ markets, investors are looking towards infrastructure,. This includes investments in renewable energy such as wind and solar farms, which benefit from stable long-term profit outlooks and may offer dividend yields in excess of 5%. It also includes investments in social infrastructure projects (such as schools, hospitals and roads) with government backing, which may also offer attractive yields.
Meanwhile, peer-to-peer lending has grown in popularity. As high-street banks have been withdrawing lending to small businesses, peer-to-peer lending has helped to fill the gap. The market is run by companies that set up platforms for loans that match lenders and borrowers. Potential lenders can choose the level of risk (and potential reward) they want to take on. Institutional investors can invest directly through peer-to-peer platforms, or they can gain access via closed-end funds.
On a slightly larger scale, the global loans market is an area in which we have invested a larger amount over recent years. Again, an opportunity has arisen due to the scaling back of lending by banks. Loans also rank higher than bonds in a company’s structure, meaning that lenders get more back if the company defaults on payment. Companies also normally rank loan repayments above bond repayments, yet interest rates are typically higher. This provides potentially attractive income, encouraging institutional investors to launch funds that allow smaller investors to take advantage of these attributes.
Insurance-linked securities also offer interesting diversification and return opportunities. These sorts of securities transfer some of the financial risks of natural catastrophes from insurers or re-insurers to the capital markets. Selection of these risks and extent of exposure to them are obviously crucial, as losses linked to hurricanes and wild fires in 2017 showed, but attractive opportunities exist in these areas following sharp increases in specialist insurance premiums.
Court cases, particularly corporate ones, can be costly. Providers of litigation finance carry the expenses of bringing carefully selected cases to trial, in return for a percentage of the damages or awards to successful complainants. If they lose, the financing company bears the legal costs. It is important to draw a distinction between such companies and the ‘no win, no fee’ division of the legal sector, however. Burford Capital, the litigation-finance provider that we hold in our multi-asset growth portfolios, operates on a much larger scale, dealing with wide-ranging and complex corporate cases.
More than a third of the world's airline fleet is now rented, and this proportion is likely to grow. Given the high costs of passenger planes, airlines are increasingly leasing planes to cope with upturns in demand. The yield that aircraft-leasing funds offer to investors is highly attractive. The asset class’s fortunes depend to some extent on the health of the airline industry and, therefore, on the global economy. But aircraft-leasing funds have generally shown a relatively low correlation to movements in equity markets, thus providing significant diversification benefits.
Investors always need to buy diversifying assets on merit, not just because they are different. But we believe that the assets outlined above do provide the potential for attractive returns with a low correlation with those provided by more mainstream assets. As part of a diversified portfolio, exposure to the right alternative-asset funds could help investors to both boost returns and smooth the ride through any future market turbulence.
The views and conclusions expressed in this communication are for general interest only and should not be taken as investment advice or as an invitation to purchase or sell any specific security.
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